Research Trends and Conclusions: Insolvency & Restructuring 2009
Emma Notfors takes a closer look at the issues facing insolvency & restructuring lawyers.
The majority of insolvency and restructuring lawyers interviewed for this book were pessimistic about the economic forecast.As Robin Spencer, at Lovells in London, pointed out, "there is no chance of recovery until the market finds its bottom." We can expect insolvency and restructuring lawyers to remain busy until that time and beyond.
Law firms are coping with the influx of work in this area by lateral hires or by importing lawyers from teams in less active practice areas. The volume of work faced by practitioners is compounded because cases are more complex than they were during the last recession. Financial practices of the past decade have seen highly leveraged transactions become increasingly common, and credit markets became so deep that they evaded the oversight of the regulators and leading banks. Lending by hedge funds and insurers further increased the difficulty of regulation, and the easily available credit on every level that fuelled this market became a factor in its downfall.
CRITICISM
As markets fall, there has been much pointing of fingers and examination of financial regimes. In the UK, politicians have been eager to lay the blame at the feet of traders, bankers and executives. Private equity and debt financing have been widely criticised in recent months for their role in a financial system seen by some as irresponsible.
Even proponents of private equity must concede that the halcyon days of its unquestioned role in the global economy are over. In a recent article in the Financial Times, Simon Walker, chief executive of the British Private Equity and Venture Capital Association, recognises that the "age of easy, even, to be blunt, lazy leverage is over". Walker also claims that the private equity industry is transforming into one that has a capacity to generate strategic and structural enhancements that could make it a "real resource for recovery". The industry, however, is facing criticism about its contribution to the severity of the current economic situation.
According to many experts, we can expect the economy to worsen. James Roome, at Bingham McCutcheon in London, believes that we are "in the early stages of the recession. It will be very slow, and nothing will survive untouched by it." There are trillions of dollars of debt set to mature in the near future, and with the current lack of liquidity in the markets, there will be little hope of refinancing, which will mean more companies going to the wall. Companies that would have been rescued in previous years are being liquidated even if they have creditable rescue plans or are still viable - banks are trying to limit their exposure and investors are proving to be elusive. All of this means that more and more distressed companies are deciding whether to restructure or pursue insolvency measures. Lawyers in all of the jurisdictions we researched have noticed a marked increase in the number of companies seeking advice on the insolvency laws.
Some insolvency cases from the early 1990s are still creating work for lawyers, and that recession was much smaller than the current one stands to be, and simpler. Restructuring processes have become more intricate as the secured positions of multiple creditor groups have become more complex. This means, of course, that the process is more expensive and so any company must consider whether they might be better off not filing for bankruptcy protection. Marshall Huebner, who co-heads the Davis Polk & Wardwell insolvency and restructuring practice in New York, exhorts companies to "never underestimate how expensive a statutory restructuring can be, especially if it involves more than two parties. In-court proceedings can be extremely expensive. Companies need to consider whether the second best out-of-court solution is not better than a bankruptcy filing, which has very substantial incremental risks and costs".
OUTLOOK
Insolvency lawyers are among the best-placed people to predict this market trend in their respective jurisdictions in the near future. Two years ago, for example, the managing partner of a prominent US law firm stopped hiring lawyers for its M&A group and concentrated instead on its insolvency and restructuring practice because of the increased demand for bankruptcy advice and expertise. Likewise, some of the lawyers we spoke to claimed that they had spotted indicators of the economic difficulties in some industry sectors as early as 2005. Because companies turn to insolvency and restructuring lawyers for advice, they are in a position to anticipate the rate of bankruptcy, which is of course symptomatic of the general state of the economy. The lawyers we interviewed concurred in their expectations of a deepening recession. Bob Thornton, at ThorntonGroutFinnigan LLP in Canada, pointed out that "this recession, in contrast to other recent downturns, is not sector-specific". This sentiment was echoed in comments from Guy Lofalk, of Lofalk Advokatbyrå in Sweden - a boutique insolvency and restructuring firm. He compared the pervasive failures of the world economy to a badly designed ship; with no watertight bulkheads, "the water is moving freely and the ship is sinking". The sectors most often identified as being at risk in the near future by the lawyers we have spoken to are real estate, construction and related industries, as well as banking and the automobile industry, including suppliers. Marshall Huebner fears the possibility of an "economic failure of 1929 proportions, with a high volume of failed businesses and lost jobs".
UNITED STATES
A combination of the rise in debt-financed consumption and speculation left the economy particularly vulnerable when consumers and homeowners began to default on loans. The subprime mortgage crisis led in turn to the collapse of financial institutions, many of which have been bailed out by the US government. Fannie Mae, the Federal National Mortgage Association, and Freddie Mac, the Federal Home Loan Mortgage Corporation, collapsed in September 2008, and both are currently under federal conservatorship.
Lehman Brothers' demise followed shortly after. Harvey Miller at Weil, Gotshal and Manges heads the team handling the case, which has also been providing work for lawyers worldwide. Because of the size and international reach of the financial services firm, the result of its collapse was a huge loss of value in the international stock markets, as unease and fears of further failures spread. Bear Sterns was another victim and was sold to JP Morgan Chase in May 2008. Washington Mutual, the largest savings and loan association in the US and the largest bank to fail in US history, faced a 10-day bank run in September 2008 that forced action by the US Office of Thrift Supervision. It was placed into the hands of the Federal Deposit Insurance Corporation and eventually also sold to JP Morgan Chase.
Banks have not been the only concerns to go to the wall in the US - most industries have seen layoffs and downsizing. American retailers have begun to fall victim to the recession. The list of significant bankruptcies has so far included specialist retailer Linens'n Things, department store chain Mervyn's and electronics retailer Circuit City, among others. Blockbuster, the erstwhile buyer of Circuit City, recently pulled out of talks amid its own financial concerns, and has hired Kirkland & Ellis to advise it in regards to ongoing financing and capital raising initiatives. There are few sectors of the American economy that look safe from the recession. The automobile industry in the US has also been affected - Chrysler and General Motors have both narrowly avoided bankruptcies, thanks to government bailouts. These industries continue to be troubled largely because of a drop in sales that has affected every aspect of the car supply chain.
UNITED KINGDOM
Across the pond, the financial sector in the United Kingdom has fared little better - if not worse. Since the run on Northern Rock back in September 2007, the troubled banks of the UK have seldom been out of the news. Northern Rock's highly leveraged business was typical of the banking sector, and its decline was followed by that of other retail banks. Bradford & Bingley was split in September 2008 in response to a crash in its share value, with its mortgage section falling under government control, and the deposits and branch network sold to Santander. Alliance and Leicester was also sold to Santander and the troubled HBOS group was taken over by Lloyds TSB, in a further addition to the list of nationalisations and takeovers. Sigma Finance, which until October 2008 was the oldest surviving structured investment vehicle, is another victim of the recession; New Star Asset Management, which had been one of the most successful firms in the City of London was forced to undertake restructuring in December 2008. Lovells is handling both of these cases.
The failures of well-known brands has contributed to further consumer pessimism, with many businesses announcing decreases in profit and household names going under. On the British High Street, the collapse of Woolworths in December was closely followed by that of entertainment retailer Zavvi, and Waterford Wedgwood has also recently gone to the wall. Linklaters is handling both Waterford Wedgwood and the retail section of Woolworths. DLA Piper recently advised Whittard, Little Chef and Zavvi on their administrations. Certain firms, most notably those in the magic circle, are seen as leaders in this field, often handling the insolvency or restructuring of companies they already had strong relationships with.
EUROPE
Although many analysts believe that Europe has been, and will remain, less hard-hit than both the UK and the US, it has still felt the effects of the credit crunch. The Icelandic government resigned in January as a direct result of its many failed banks. In Germany, bankrupt real estate company Level One, which owned 28,000 real estate units, has provided work for several firms after it became insolvent. Car companies in Germany are being affected by the difficulties experienced by US parent companies, notably Chrysler and GM, and firms are expecting more work owing to the dominance of investment from the US and UK, according to one of our sources. This is true of Sweden as well, as has recently become clear from Saab's difficulties.
Aside from the international bank-buying activities of Santander, the Spanish economy is showing signs of stress as well. Property developer Martinsa-Fadesa declared itself insolvent in July, Promociones Habitat followed suit in November last year and unemployment is on the rise. Spain's relatively new insolvency regime (established in 2004) now faces a trial by fire. Further North, Pekka Jaatinen of Castrén & Snellman in Finland says that construction companies in particular are suffering and even "companies that are solid on balance sheets are being affected by economic events in the rest of the world, which is causing problems."
REGIMES
Insolvency regimes the world over are being evaluated for their ability to deal with the rise in defaults, and how this will affect a country's ability to recover from recession. America's relative leniency and comparatively high rate of restructuring can mean that its firms will be more likely to survive. In Europe, insolvent companies are treated more harshly, and the rate of liquidation is higher. In France, for instance, ratings agency Standard & Poor's research shows that 9 in 10 insolvencies result in liquidation. It anticipates that between 60 and 75 European companies from its speculative-grade category could default on a total of €20 billion to €25 billion of debt in 2009 and 2010.
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As world markets emerge from the exceptionally long period of unbroken growth enjoyed until recently, a prolonged downturn can be expected. It had been a relatively inactive period for insolvency specialists, who are now far busier than their colleagues. Although the downturn is creating work in this area, in cannot make up for the shortfall in work in other practice areas - the lack of liquidity in the markets means that many firms are restructuring their practices, enforcing payroll cuts or even laying off lawyers in practice areas that have become quiet.
Leveraged companies are more likely to be affected by collapses of banks, lenders and defaults, as their finances have a far greater exposure. These will also create the most work, as lawyers will be needed to represent all interested parties in the fallout. The US bankruptcy code, which is more lenient to insolvent companies, tends to result in more restructurings than in Europe, which could mean that the US will weather the economic storm better. Some relatively new bankruptcy codes in Europe will be severely tested in the coming months, and time will tell how many companies survive the recession. In previous years, insolvency teams have had to compete for work. Now, there is more than enough to go around.